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A Prescription for Profits? CVS Caremark Corp

December 24, 2008 | About:
CVS Caremark [NYSE:CVS] Dec. 23, 2008 price: $26.52

52-week range: $23.19 (Nov. 21, 2008) - $44.29 (Jun. 5, 2008)

Yield = $0.069 quarterly = 1.04%


After recently closing on the acquisition of Longs Drugstores, CVS is now the largest integrated provider of pharmaceutical services. They fill over one billion prescriptions annually with over 6200 locations in 40 states. Their pharmacy benefits division is a leader in its field nicely complimenting the retail drugstores. 2008 revenues should exceed $86 billion and 2009 sales are projected to be almost $94 billion with the full year’s contribution from the former Longs units.

CVS shares have been knocked down from an all-time high of $44.29 last June to just $26.52 today despite the company’s excellent operating results.

The year wrapping up next week will be the seventh straight year with higher EPS and the fifth consecutive year with an increased dividend.

These are high-quality, low volatility shares (beta =0.80). Value Line assigns CVS Caremark a financial strength rating of ‘A’, with ‘stock price stability’ and ‘earnings predictability’ rankings of 90th and 95th percentile compared with their 1700 stock universe.

When CVS offered to buy Longs many thought they were low-balling their bid and that Walgreens or someone else might launch a higher tender. Due to the current convoluted credit markets the deal was able to close without needing to be raised. CVS management has proven adept at integrating acquired chains having assimilated many Eckerd stores in 2004 and the Save-On and OSCO chains in 2006.

Here are the (split adj.) per share numbers for the past six years as reported by Value Line. 2008 figures include estimates for Q4 ending Dec. 31st:

Year …..… Sales ..…… C/F …… EPS …… Div …...… B/V …. Avg. P/E

2002 .….. 30.76 …… 1.29 ……0.88 …… 0.12 …... 6.29 …… 16.8x

2003 …... 33.62 …… 1.49 ……1.03 …… 0.12 …... 7.31 …… 14.1x

2004 …... 38.15 …… 1.75 ……1.10 …… 0.13 …... 8.43 …… 18.4x

2005 …... 45.45 …… 2.15 ……1.38 …… 0.15 …... 9.96 …… 19.6x

2006 .….. 53.06 …… 2.50 ……1.57 …… 0.16 …...11.75 …… 19.3x

2007 .….. 53.14 …… 2.59 ……1.92 …… 0.23 …...21.66 …… 19.1x

2008 .….. 60.50 …… 3.35 ……2.43 …… 0.26 …...24.00 …… 13.6x

With this year’s estimate at $2.43 and next year’s consensus centered on $2.70 CVS has a trailing P/E of just 10.9x and a forward multiple of 9.8x.

Those are the lowest valuations since the company was spun off from Melville in 1995. How cheap are these shares today? The best previous buying opportunity on CVS came in Q1 2003 when the shares hit an absolute price of $10.90 on trailing earnings of $0.88 for a 12.4 P/E. Holders of CVS back then saw their shares surge 189% to $31.60 by mid-year 2005.

Today’s well covered dividend yield of 1.04% may not seem generous but it is comparable to the 1.1% that buyers at the exact low in 2003 received and higher than at all other times since their 1995 spin-off.

While we may not see future multiples go right back to their historical levels I think a 14 or 15 multiple should be seen again before the end of 2009. Even 14 times year ahead expectations of $2.70 would lead me to a 12-month target price of at least $37.80 or + 42.5% above today’s closing quote.

Is that reasonable? CVS shares hit highs of $36.10, $42.60 and $44.30 in 2006 – 2007 and 2008 all when fundamentals were less favorable than they are right now. The dead lows in 2006 and 2007 were $26.10 and $30.50.


If you want a lower risk way to play CVS Caremark and are comfortable with options here is a combination play that makes sense to me.

…………………………………........................………….. Cash Outlay … Cash Inflow

Buy 1000 CVS @ $26.52 ………...............………….. $26,520

Sell 10 CVS Jan. 2010 $30 calls @ $3.40 ………...............…………… $3,400

Sell 10 CVS Jan. 2010 $25 puts @ $4.60 ……….............……………. $4,600

Net Cash Out-of –Pocket ………..............…………… $18,520

If CVS shares are above $30 (+13.2% from our starting price) on expiration date - Jan. 15, 2010:

Your shares will be called. You will receive $30,000.

Your $25 puts will expire worthless (a good thing for you as a seller).

You will have no further option obligations.

You will hold $30,000 for your original cash outlay of $18,520.

That’s a maximum potential gain of $11,480/$18,520 or + 62%.


If CVS shares are unchanged on expiration date:

Your $30 calls will expire worthless.

Your $30 puts will expire worthless.

You would have no further option obligations.

You will still own 1000 shares of CVS worth $26,520 for your original

outlay of $18,520 for a gain of $8,000 or + 43%.


If CVS shares are below $25 on expiration date:

Your $30 calls will expire worthless.

Your $25 puts will be exercised. You would be forced to buy another

1000 shares for an additional $25,000 outlay.

You would still own the original 1000 shares of CVS.

You would have no further option obligations.



What is the risk on this trade?


Break-even on the original shares would be the $26.52 purchase price less the $3.40 /share call premium = $23.12 /share.

Break-even on the $25 puts would be the $25 strike price less the

$4.60 /share put premium = $20.40 /share.

The break-even on the whole trade is thus $21.76 /share or 17.9% below the starting purchase price of $26.52 /share. That price is lower than the low prices touched at any time since 2004 when full year EPS were $1.10 versus this year’s likely $2.43.


Disclosure: Author is long CVS shares and short CVS options.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.gurufocus.com/peter_lynch.php
http://www.TalkMarkets.com
http://www.MutualFunds.com

Visit Dr. Paul Price's Website


Rating: 4.2/5 (6 votes)

Comments

Amit Chokshi
Amit Chokshi - 5 years ago
Why don't you ever present the downside in terms of percentages. You present the percentage gains when the strategy is up or flat but never for when it's down and present the "risk" as the break-even and average price. Don't you think the downside in terms of percentage matters?

Your max gain is 64% since your outlay is $18,250 not $18,520. Minor point the main point is if CVS is at $10 the CVS stock you bought for $26,250 is down $16,250 and you are FORCED to buy CVS stock that is worth $10 per share for $25 per share meaning you are down $31,250 or 71%. If CVS is at $5, you're down 126%. My math is dead right.

All this strategy is is HIGH RISK/HIGH REWARD INCOME CHASING. I only get hopped up on these because it's clear that not everyone here is pro investor or knows about options. If they do this strategy, maybe it works 3/4 times, maybe 9/10, but that one chance will happen where it does not work and will cause massive losses. There's no need to get greedy and sell naked puts and amp up the risk.

For example, you could go out and buy that same amount of CVS stock and sell $20 strike price calls for $10.20 that are due in 2011. I would never recommend this because selling a call with a strike under your purchase price is usually pretty stupid. So your initial outlay would be $16,320. Your max LOSS is 100% but you capped your gain at 22.5%. If CVS is at $5 you're down 69% while in the strategy you suggest you'd be down 126%. At $10, your max loss is 42% vs a loss of 71%. THe main point is that these options are all about guarenteed income vs risk. You're not FORCED to buy CVS at $25 when it's at $10 so you're saving yourself some skin at the expense of upside, the point is you extend a significant level of risk on the downside and you pay no attention to the value of the option. The underlying is important but you make no attempt to discuss if you are being adequately compensated for selling these options. What's the vega on those options? Is it historically higher/lower? What's the delta/gamma on those?

Of course, CVS is a real company and can't possibly drop that much. tyco, calpine, target, any financial the past year, any homebuilder, many mall retailers, TGT, GE, SBUX, MCD back in 2002...CVS can't do what those stocks did right in terms of falling massively so it's stupid to consider CVS at anyhing under $15...

Go ahead, rate this one post. I'll wait for your next idea maybe MSFT? You can buy 1000 shares of MSFT at $19,250. Why not sell 10 contracts for the 2011 calls at strike $20 for $4750 and the puts at strike $17.50 for $4500 for a net cash outlay of $10,000?

If MSFT goes to $20+ you make 100%, woo hoo. If MSFT is at $17.51, you max 75%, what a great trade.

Oh but, if MSFT goes to $10 (NEVER WILL HAPPEN), your MSFT investment down $9,250 and your forced to buy MSFT that's worth $10 for $20 per share meaning you're down $10k there for a total of being down $19,250 or down 93%.

Point is these option strategies are almost meaningless, when you're selling naked puts you're basically putting the noose around your neck and hoping the ground under you is stable. Andrew Lo at MIT showed a strategy that returned 40% a year until 2000, all u had to do was basically sell puts against the S&P during the last raging bull market and in 2001 you'd have lost it all.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
Dizzy,

Any stock you buy can theoretically go to zero. So any outright purchase could decline 100% no matter what underlying stock you might hold.

If you bought CVS outright at $26.52 it could drop by $26.52/share. With the trade outlined in my write-up your maximum risk is $23.12 /share or 17.9% less than for those who purchase shares and sell no options.

You obviously don't understand the intent or the execution of my strategy and shouldn't be using it.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
Dizzy,

Why don't you analyze CVS Caremark and tell me what you think it is worth.

I'd be very curious to see your view on its true value and how you arrived at that figure.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
Dizzy,

I ran the numbers on your MSFT combo and they look very good if you think MSFT will be higher or not too much lower by Jan. 2011.

Here are the true figures:

..........................................................................Cash Outlay.... Cash Inflow

Buy 1000 MSFT @ 19.25 ....................................... 19,250

Sell 10 2011 $20 Calls @ 4.75 ....................................................... 4,750

Sell 10 2011 $17.50 Puts @ 4.50 .................................................. 4,500

Net cash Outlay ................................................... 10,000

So far your numbers are spot on.

Here is where you miss the boat...

Break even on the original shares: $19.25 - $4.75 = $14.50

Break even on the $17.50 puts: $17.50 - $4.50 = $13.00

Net Break Even on the whole trade = $13.75 /share.

_______________________________________________________

These two calculations you had right.

If MSFT is $20 or above on expiration date you'll have:

$20,000 for your $10,000 or a 100% gain cash-on-cash.

If MSFT declines to $17.51 on expiration date:

$17,510 for your $10,000 or a 75.1% gain cash-on-cash.


These are huge returns on a stock that either moved up just 4% to $20 or even declined 9% to $17.51.

__________________________________________________________

Here is where you are SO WRONG...

If MSFT went to $10 on expiration:

You would own 2000 shares worth $20,000 on a net outlay of $27,500 for a loss of 27.3% cash-on-cash.


Someone who bought MSFT outright at $19.25 and saw the shares drop to $10 would be down 48.05%.

Those who did the combination would only be down 27.3%.

Which is more conservative?

Amit Chokshi
Amit Chokshi - 5 years ago
My initial calc on losses was wrong because I used a $20 strike instead of a $17.50 for the sold put but your math is STILL VERY WRONG on the LOSSES. The net outlay is the same IRRESPECTIVE of where the stock is. So let's get this right, you keep the outlay to $10k when the stock goes up to show a higher gain but when it goes down, you add the premiums and stock value? That's is wrong.

We buy 1000 shares of MSFT at $19.25, we sell calls at $4.75 and puts at $4.50 we have a net outlay of $10,000 as a result. That does not change no matter what. So when MSFT is above $17.51, our gain is $7,510 or 75% on our $10k cash outlay. But when MSFT is under $17.50 we now all of a sudden have a $28,500 cash outlay to reduce our percentage losses? the outlay does not change.

On Jan 2011, MSFT is at $10

The original 1000 shares at $19.25 for $19,250 are now worth $10,000 = LOSS of $9,250

We have to BUY 1000 shares of MSFT for $17.50, i screwed up and calculated that off a $20 strike. The actual return is -75%.

I just bit the bullet and went to excel to make this a little more itemized instead of using my HP calc. For anyone that wants to know how to calculate their returns using a covered straddle write do this, it's very easy and will help understand the return profile:

Go to excel

Cell A1 type in: stock, Cell a2 type in: sell call at 20, cell a3: sell put at $17.50

now in cell b1 put in -19.25 as this is our outflow to buy msft

cell b2 put in 4.75 as this is the call prem we receive

cell b3 put in 4.50 as this is the put prem we receive

In B4 sum it up and you get -10, this is our net cash outlay

Now go to cell E1, type in stock price, in cell F1 type in 21, this is a cell where we will mess with the stock price at expiration to figure out what the different returns are, for now let's assume MSFT is at $21 at expiration so put in 21 in cell F1.

In cell E2 type in call strike, in cell F2 put in 20 as this is the strike price of the call we sold

In cell E3 type in put strike, in cell F2 put in 17.50 as this is the strike price of the put we sold

No go to cell C1, make it a formula that says =F1, you want this linked to cell F1 so it will adjust the price.

Now go to cell C2, put in the following formula, =IF(F1
This says if the stock price is under $20, the call option is 0, and if not, the subtract the stock price from the call strike

Now go to sell C3, put in =If(F1>F3,0,F1-F3)

This formula says if the stock price is higher than the put price, the put is 0, if not subtract the put price from the stock price.

In cell C4 sum it up, if you have it set up as i described, you shoud have a 20 as the total in C4. Now in cell C5 put in =(C4+b4)/(-b4) which should result in 100%

Remember how i said the max gain on this is 100% and stockdoc agreed? let's test it out, put 50 in cell F1, it should still show a 100% in C5. Put in 10000 or put in 22, the max gain is 100%. Now put in 17.51 in cell F1, you should see the gain as 75.1% which we all agree on. Now put in 10 in F1, the return is -75%. Put in 8 in cell F1 it's -115%.

Hope this helps, for some people it may be more intuitive to show gains so you can go to sell H1 and put in C1+b1 and copy that formula down to H2 and H3 and then sum it up in H4. In cell H5 type if -H4/B4, same result.

The point is this shows that a covered straddle write can get you good returns if the stock is stable but as i've said before, the tail risk exposes you to massive losses.

go to this link

http://books.google.com/books?id=db8v0As79qAC&pg=PA296&lpg=PA296&dq=naked+put+returns&source=bl&ots=siM9uw1K73&sig=l6qEMWvsXRHzrWiifuFF7UBxC_o&hl=en&sa=X&oi=book_result&resnum=1&ct=result#PPA304,M1

go to page 304, look at that payout graph on 20-1, it shows in dotted lines a payout for a covered call and in a thick dark line the payout for a covered straddle write. Look at the steepness of the covered straddle write, it offers higher return and HIGHER RISK.

Here is another characteristic:

Risk/Reward Characteristics

Profit potential is limited, but greater than a Covered Write. Maximum profit equals Straddle premium plus strike price minus initial stock price. Losses are unlimited because the investor could end up with a long stock position twice the initial size. Because of this fact, the investor must carefully consider the initial size of the spread!

Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
Dizzy,

If you assume a $10 final price for MSFT:

You have neglected to reduce your outlay (in your loss calculations) by the amount you received for selling the options at inception.

You are counting the originial buy as $19,250 and the second buy at $17,500 without ever deducting the option premiums (which reduce the net outlay by $9,250).

That's why your numbers are SO WRONG!



Your total outlay is the $10,000 originally paid plus the $17,500 needed when the $17.50 puts were exercised.


That's $27,500 total. You would own 2000 shares at $10 (if you are assuming a $10 final price). You would hold 2000 shares X their $10 share price = $20,000 for a $7,500 total loss.

Someone who bought 1000 shares for $19,250 (with no options written) would have sustained a $9,500 loss in the same time period with the same drop in price.

Of course I didn't use an additional outlay in your example when the stock went up as the puts would NOT be excercised and no further cash would be needed. .

You have ZERO KNOWLEDGE concerning options.

You should never go near an options transaction with your total lack of knowing how they work.


All your Excel calculations are worthless crap as you don't understand the concept you are talking about. Garbage in- Garbage out

Amit Chokshi
Amit Chokshi - 5 years ago
The initial investment DOES NOT CHANGE based on whether you have a loss or gain. Although you have called me stupid in a private message my Excel formulas are 100% CORRECT.

The gain/loss is correct, at $10 you lose $7,500 as my EXCEL FORMULA SHOWS IF YOU RAN THE FORMULAS but the loss is on $10,000, NOT $27,500. The $10k ALREADY FACTORS THE PREMIUMS IN IT and any assumed assignment, how do you not get that? Did you use the formulas i laid out?? You pay out $19,250 for an initial MSFT stock and RECEIVE $9,250 in OPTION PREMIUMS, that's ALREADY FACTORED IN YOUR INITIAL INVESTMENT. THAT WILL NOT CHANGE based on whether MSFT is at $5 or $500.

But apparently, if MSFT is $17.49, the formula changes right? So at $17.49, we have $7.48 in gains on an investment of $27,500 or a gain of 27.2% but at $17.51, the gain is on $10k of invested capital so we have a 75.1% return? So a difference of $0.02 can cause a swing of 48% in our returns? You're proving you have no idea how option pay outs and investment calcs worth, go into an option trader and show him those returns and get laughed out of the room. Make that same argument, um yeah when it's at $17.49 we have just a 27% return but at $17.51 it's at 75.1%.

If MSFT is at $15, the return is 25% but according to you it would be at 9%. So if MSFT is at $1, someone just buying the stock straight would be down 95%. But according to your ridiculous math, someone by selling naked puts they'd be down just 93%. What a joke, the actual return is that the person would be down 255%.

Anyone that wants to actually learn something should use the formulas I laid out in my prior post. Go ahead and put in different scenarios. Put in $17.49 for the stock price or $17.51 and see how ridiculous Stockdoc's calculations sound.

Even forget about any stock assignment from the call/put to make it elementary easy. If you use my Excel formulas I laid out, you'll see in the H column I laid that out. At $10, the stock value is down $9.25. The call option premium is $4.75 we keep. But then the put we write will have blown up on us and will be down -$3 on it because we sold a put at a s strike of $17.50 for $4.50 put premium. With the stock at $10, the intrinsic value of that put will go up by $7.50 ($17.50-$10) meaning we're getting kicked in the teeth on that for a NET LOSS of -$3. So as I said before, the GAIN/LOSS FACTORS IN THE OPTION PREMIUMS RECEIVED. We add the -$9.25, the +$4.50 and the -$3 for a loss of $7.50. You DONT CHANGE THE INITIAL INVESTMENT and hopefully people can see how ridiculous that is.

Let's do an example of how ridiculous stockdocs math is. Say we buy MSFT at $19.25 and just sell the put under it at x=$17.50 for $4.50. So we own the stock, sell a put, simple. Our total net outlay is $14.75. So if MSFT is at say $18 on expiration, we make 22%, while a straight buy would be down 6.5%. If MSFT is at $30, we'd be up 103% while the straight holder would be up just 56%.

Simple right? Ok but now say MSFT is at $12. We'd be down $7.25 on our stock but then our put we sold for $4.5 would be down an additional $5.5 because the stock is at $12, we sold a put for a $17.50 strike for $4.50. So we'd be down $4.5 (the income we received for the put)-$5.5 (but now the put we wrote is is against us) or down $1 for a total of down $8.25. That's a loss of 55.9% on our initial investment of $14.75 and THE CORRECT WAY OF CALCULATING YOUR RETURNS.

However, according to stockdoc, you would now include having to buy MSFT at $17.50 as part of the outlay. Meaning you had an outlay of $14.75 but now you have to ADD $17.50 to that. Then you would calculate that loss of $8.25 against an outlay of $14.75 + $17.25 or $32.25. So based on stockdoc's calculations, you would only be down 26% while if you just bought MSFT at $19.25 without any sale of naked put options, at $12, you're down 38%.

I usually give up after a while but as I've said i've felt these option strategies proposed are so badly explained on the downside I feel like i Have to speak up. First, on the surface does stockdoc's math sound intuitively correct? I can have my cake and eat it too? I can sell a NAKED PUT under my stock, so when it goes up I always make more than a straight stock purchase and when it goes down big I still have a higher return than the straight stock? Meaning higher return/lower risk??! I bought MSFT and wrote an option whereby no matter what happens, if MSFT goes under $17.50 i have to pay $17.50 for it so if MSFT is at $12, 8, $4, I still am in better shape than someone who did not take on that risk and just bought the stock?

According to stockdocs math, if MSFT is at $1, the guy that bought MSFT at $19.25 and wrote a naked put at $17.50 would be down just 94% because the MSFT stock would be down by $18.25 and the option put would be down by $12 (intrisnic value of the put went up and agaisnt us, we wrote the put at $4.50 at X=17.50, but at $1, the put has gone against us by $16.50 so it's a net loss of $16.50-$4.5 that we received - so see the premiums are included or $12). So the total we're down is $30.25. But stockdoc would say the outlay is not $14.75, it's actually $32.25. So the loss is just 94%. But if you just bought MSFT stock at $19.25 and rode it to $1 you'd be down 95%.

So wouldn't it make sense to write as many put contracts as possible? Let's take stockdocs math a step further. Let's say we buy MSFT at $19.25 but we now sell a $17.50 X put at $4.50 and we sell a $15 X put at $3.50, both Jan 2011. So we have a total outlay of $11.25. Now if MSFT is at $20, we make 78% on our investment but a straight stock investment makes just 4%.

At $18 we make 60%, the straight buy of MSFT is a loss of 6.5%. Ok, but now here's where's stockdocs math gets laughable. If MSFT falls to $12, the actual return the person that did that trade would be -69%. You'd be down $7.25 on the stock, the put at $15 would be still up $0.50 because you wrote it for $3.50, so at $15-12, you're giving back $3 and keeping $0.50. Then on the $17.50 put you'd be down $1 ($5.50-$4.50 you received for writing it, the $5.50 is from $17.50strike - current price of $12). So you'd have a loss of $7.75 on an intial investment of $11.25 or be down 69%. The guy that just bought MSFT for $19.25 and is now at $12 would be down 38%.

But stockdoc would say hold on, your initial investment changed. You have the initial investment of $11.25 but then you have to add the $17.50 and the $15 to your initial investment. So you would be down $7.75 on a total "investment" of $43.75. So you would have written two naked put contracts under your MSFT investment and be down 18% with MSFT down to $12!!! compared to a guy that just bought MSFT stock and was down 38%.

If MSFT was at $1, a guy that bought MSFT and wrote a naked put at $15 and $17.50 would be down just 93% vs the 95% a guy that bought MSFT outright and did no option selling based on stockdoc's math.

Does this make sense? Of course it doesn't because it's wrong. I'd love to see stockdocs lay out where my errors are on my sold put examples but i expect more insults.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
You are hopeless and clueless.
Amit Chokshi
Amit Chokshi - 5 years ago
Please tell me what your calculated returns would be based on selling two puts at $15 and $17.50 strike when owning MSFT if MSFT is at $12, of course you wo't since it wil prove i'm right and you're wrong. keep rating yourself five stars too, and mine 1, you are clueless. I post stuff that helps people here, if most follow your ideas they'll lose their shirt.

Let's here your next big stock idea, what's next WMT, sell some puts and calls for a SAFE 80% return and somehow less risk than owning the stock even if WMT drops to $20. right keep those ideas coming.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
DIZZY MATH:

The following is pasted from Dizzy's commentary #5 above:

We buy 1000 shares of MSFT at $19.25, we sell calls at $4.75 and puts at $4.50 we have a net outlay of $10,000 as a result.


Ok, here's a translation:

.............................................Cash Outlay... Cash Inflow

Buy 1000 MSFT @ $19.25 ..........$19,250

Sell 10 $20 calls @ $4.75 ...............................$4,750

Sell 10 $17.50 puts @ $4.50 .........................$4,500

Net Cash Outlay .........................$10,000

That part is right.

His next statement:

That does not change no matter what. So when MSFT is above $17.51, our gain is $7,510 or 75% on our $10k cash outlay.


Not really completely right. At exactly $17.51 you would have a net gain of 75.1%. But since you own 1000 shares your gain could be much larger. You would see your maximum gain grow until MSFT shares topped $20 by expiration date.

If the shares hit $20 or higher by then you would see your $17.50 puts expire and your 1000 shares turn in to $20,000 cash after being called away.

On that original $10,000 outlay Dizzy described that is a 100% gain (not counting dividends received along the way).



Here is where DIZZY really lives up to his name:

But when MSFT is under $17.50 we now all of a sudden have a $28,500 cash outlay to reduce our percentage losses? the outlay does not change.


If MSFT was under $17.50 the puts would be exercised making the seller of the puts buy 1000 additional shares for an extra $17,500.

You would now have put out an original $10,000 at inception plus the extra $17,500 upon exercise of the puts.

$10,000 + $17,500 = $27,500 out-of-pocket cash.

Total holdings of MSFT now = 2000 shares.

Average net cost of MSFT = $27,500/2000 = $13.75/share.

Dizzy's next claim:

On Jan 2011, MSFT is at $10

The original 1000 shares at $19.25 for $19,250 are now worth $10,000 = LOSS of $9,250


WRONG. With a cost of $19.25 less the $4.75 call premium you paid only $14.50/share net - not the $19.25 Dizzy claims. The loss if MSFT was down to $10 is ($4,500) not ($9,250)- quite a difference.



Dizzy then said:

We have to BUY 1000 shares of MSFT for $17.50, i screwed up and calculated that off a $20 strike. The actual return is -75%.


WRONG again.

Since you sold $17.50 puts for $4.50/share your net cost would be $17.50 - $4.50 = $13.00 /share.

Even with MSFT at $10 that would be a net loss of ($3000)- not the ($7,500) loss that Dizzy proclaimed.

Dizzy's math was even worse than that as he declared (erroneously) that a drop from $17.50 to $10 would be a 75% loss. Even if that drop were real it would be only a 42.86% decline.

In his example, though, you would own the shares at $13 not $17.50/share.

A drop of $3 from $13 to $10 is a 23.07% decline - not a 75% drop as Dizzy indicated.

**********************************************************

Most importantly, his assumption of a decline in MSFT to $10 /share would put that blue chip stock at a (split-adjusted) price not seen since April of 1997. At that time MSFT's EPS were $0.23 versus a trailing $1.90 today. The dividend back then was zero while today it is an annual $0.52. Book Value has tripled and MSFT holds over $20 billion in cash today.

**********************************************************

This column was not about MSFT anyway.

I stand behind all my numbers and calculations. Dizzy's are clearly the work of someone who does not understand options (or even basic math for that matter).

Amit Chokshi
Amit Chokshi - 5 years ago
Stockdocks, you just don't know how to calculate returns. Again, based on your math, someone could sell naked puts at two different strikes on a stock they own and if the stock implodes they still are better off than the straight owner. If you can't intuitively grasp that that is not possible, that's scary.

Re when MSFT is at $17.51 to $20 I SAID THAT MAX GAIN WAS 100%, how is that "not completely right" when I said at $17.51 you have a gain of 75.1%? Can you even read my previous posts, I said 75.1% to a MAX GAIN of 100%. I said that in my FIRST REPLY TO YOUR POST

"If MSFT goes to $20+ you make 100%, woo hoo. If MSFT is at $17.51, you max 75%, what a great trade."

and then you say i "described" a 20+ MSFT shre price yielding 100%? Wht is there to "describe" it is a 100% MAX GAIN.

Re MSFT at $10:

We can agree that the net outlay is $10 for MSFT when we do this trade of $19.25, receive call and put premium for $4.75 and $4.50.

I BROKE OUT EACH COMPONENT OF THE TRADE TO MAKE IT EASIER TO UNDERSTAND when I said assume MSFT is at $10.

I said the original shares of MSFT at $19.25 would be down $9.25 - THAT IS TRUE

I said you would KEEP THE OPTION CALL PREMIUM OF $4.75 - TRUE

I said on the SOLD PUT YOU WOULD BE DOWN $3 this is because at $10, the PUT BLEW UP ON YOU, YOU SOLD IT FOR $4.50 at $17.50, AT $10, the put is at least $7.50 MEANING YOU ARE DOWN $3 on that put or you NOW OWE YOUR BROKER $3.

So -9.25+4.75-3 = -7.5. How do you think this would show up in a prime brokerage account?

It would show MSFT stock in at $10, the call option would be a $0, and then put option would show a -$7.50. The total account value would be at $2.50 from an initial investent of $10. For anyone else that wants to learn things the right way and not mindlessly doublecount, this is what the account would look like at the start. Let's also assume this is all the money in our account:

MSFT $19.75

Call option -$4.75

Put option -$4.50

Account Net Value $10

Ok, for you rookies (prob stockdocks too), this is what the account would show for our values. THe options are negative value because we sold them.

Ok so now let's go to exiration with MSFT at $10

MSFT $10

Call $0

Put -$7.50

Account Net Value $2.50

So why would our account look like this? Ok, well MSFT at $10, that's obvious right? we all have trading accounts so we're familiar with stocks beinq quoted in our account. The Call would be at $0 because we made the full return on that. The call expired worthless so that negative $4.75 went to $0, we MADE $4.75. But because MSFT is at $10, that put we wrote blew up on us. At $10, the put value is $7.50 or $3 more than what we wrote it for. So add that up at the total account value is $2.50.

So when you calc the gain/loss it would be current net value of $2.50/starting account value of $10 minus 1 or -75%.

So to prove this is right, let's show the "trading account" for when MSFT is at say $19.

MSFT $19

Call $0

Put $0

Net account value $19

So in this situation, our MSFT stock is down $0.25 but the calls and puts are zero'd out because we MADE that money, remember when you sell an option its recorded as a debit or negative. and when you make money on a sold call it zeros out. So at $19, you have a 90% return on the initial investment.

Anyone that is familiar with calculating investment returns KNOWS that the initial investment does NOT CHANGE. I said let's assume that this money is all we had in our account, right? STockdocks thinks you can magically make some capital appear and use that for calculating your returns. Worse, he's just double counting premiums, hopefully thinking about this from a trading account perspective can help some of you in figuring this out.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
Dizzy,

Have it your way. Don't count paying for the newly 'put' shares:

If the $10 original per share outlay went to $2.50 the combination writer would be down $7.50/share.

The person who bought MSFT at $19.25 and saw it go to $10 would be down $9.25/share.

In total dollars the combination writer would still be better off.


Unless you think Microsoft shares are going down to $10 your whole thesis regarding this is meaningless.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
CVS showed an insider buy on December 29, 2008:

Bought 9182 shares @ $27.34 for $251,000

CVS closed yesterday at $29.38/share.
Dr. Paul Price
Dr. Paul Price premium member - 5 years ago
CVS Caremark Corp. (CVS) posted a 17% increase in fourth-quarter net income as sales and margins rose and the nation's largest drug-store chain saw retail profit climb.

Pharmacy operators have been cutting costs, including trimming their work forces, as the weak economy has led consumers to fill fewer prescriptions. CVS, which last month said the trend would continue for most of the year, has been aggressively promoting discount drug programs, as have several other drug chains, a move that can increase sales among the uninsured but could also threaten margins.

CVS last month warned investors that 2009 margins in the CaremarkRX pharmacy-benefits business, acquired for $27 billion in 2007, would be tight after it lowered prices to keep clients.

CVS posted net income of $949.3 million, or 65 cents a share, up from $811.2 million, or 55 cents a share a year earlier. Earnings from continuing operations, excluding acquisition-related charges, rose to 70 cents from 58 cents.

Revenue rose 10% to $24.14 billion.

Analysts polled by Thomson Reuters were expecting earnings of 69 cents a share on $23.29 billion in revenue.

Gross margin climbed to 21.6% from 20.3%.

Retail revenue increased 19% amid October's acquisition of Longs Drug Stores as same-store sales rose 3.6% - 1.8% at the front end and 4.5% at the pharmacy despite increased generic-drug usage crimping the pharmacy figure by 2.6 percentage points. But those higher-margin products helped push retail earnings up 35%.

Revenue in the pharmacy-services segment climbed 1.5%, though adjusting for the impact of new generics, it would have grown 7.8%. Processed claims rose 18% due to an acquisition and increased enrollment in CVS' Medicare Part D business. The segment's profits edged up 0.8%.

CVS has emerged as one of the largest survivors of a bruising, multiyear consolidation of the U.S. pharmacy business. The Longs takeover made CVS the nation's largest pharmacy chain by number of stores and expanded its footprint into Western markets where it has been weak.

CVS Caremark last month boosted its quarterly dividend 11%, citing its continued strong financial performance and significant cash generation, marking the sixth consecutive year of increases.

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